Want to read this article later?
Just tap MyLCN+ to save it to your account
How do international banks and English lawyers help in the movement of global trade?
Silver mining in China, coca bean growing in Ghana and iron ore extraction in Russia would seem at first glance to have little in common. However, an important link between them is that all are economic activities needing significant finance to enable them to take place. A second link is that all are carried out in countries where borrowers can find it difficult to obtain large-scale commercial loans from local banks. Put simply a coca bean producer in Ghana owns a valuable product but can lack the finance to get it from the land into warehouses and then on to ships for export to a purchaser.
Structured trade and export finance – an area of the banking world dominated by European banks and often assisted by English law firms – can provide a solution to this short-term financial problem. Banks lend money to emerging market borrowers to finance the extraction, growth, production and sale of metals such as copper, zinc and gold; soft commodities such as sugar and soybean; and hydrocarbons like oil and coal. This ‘behind the scenes’ financing plays an important and perhaps overlooked role in enabling global trade to happen.
The involvement of banks in emerging markets in Africa, Asia, South America, the Commonwealth of Independent States (formerly the USSR) and Eastern Europe is not motivated by altruistic development goals. Instead it is driven by the same aims as all banking business - to lend money to a borrower and to make a return through the borrower repaying the loan together with interest. In fact, given the large price rises in many types of commodity over recent years, emerging markets trade finance can be a lucrative area for banks and those involved in commodities trading. There is great competition among the banks to 'win' the chance to provide money.
How do banks structure the transactions?
The amount of finance provided to a borrower in an emerging market varies from transaction to transaction but loans of over $500 million are not uncommon. With such large sums advanced into potentially unstable markets, the key consideration for a lender is the structure of the transaction. Or, to put it more simply, the bank needs to think about how the money advanced will be repaid. The basic structure used for most transactions is the following:
- The bank advances money either directly to the producer or grower in the emerging country or via an intermediary buyer, often called an ‘offtaker’.
- Using the loan, the commodity is grown/produced and exported to international buyers.
- Cash from the sale of the commodity is paid by the buyers into a designated 'offshore' account controlled by the bank rather than being returned to the producer/grower. Money in this account is used to repay the loan and interest with any excess returned to the producer/grower.
Within this simple structure there will be a number of variations for each transaction. Pre-payment financing involves an 'offshore' offtaker effectively paying the producer for the commodity in advance and arranging the onward sales contracts. Pre-export finance is more similar to a traditional bank loan advanced directly to the borrower.
Whatever structure is used, the transaction should - if structured correctly - be 'self-liquidating'. This means the sale of the commodity should provide enough funds to both repay the loan and cover the bank’s profit margin. To achieve this, the bank needs to consider a range of business issues, many of which require specific advice about the law and business practices in the borrower's jurisdiction. For example, the tax position in the local market may mean the borrower has to withhold tax on interest payments. There may be exchange control requirements that restrict the import/export of foreign currencies. All these can impact on eventually recovering the full amount of the loan.
How are lawyers involved?
Surprisingly, in an area of business where many of the financing banks are French and German and the borrowers are all located outside the United Kingdom, English law is used for most of the documents in a transaction. English law is viewed as adaptable to the varied types of deal structure and enforceable both in England and many overseas jurisdictions. Although English law may govern the main transaction documents such as the loan agreement, a trade finance lawyer works in tandem with local lawyers in the borrower's jurisdiction. A challenging part of the work is assessing when the bank’s position would be better served if local law were used for a particular document in the transaction.
The lawyer's aim is to protect the lender’s position at all times. The lawyer needs to ensure the legal documents allow the bank to either directly recover the money lent or, if required, take possession of the underlying commodity so it can sell it on. As with any form of lending it is usually a requirement for the bank to have security over the asset it is financing so in the event of default or non-payment it can take back the asset. Taking security is easy in residential lending where a mortgage over a fixed property asset is simple to arrange and easy to enforce. But it is more challenging in trade finance where the rules on taking security over different types of commodity vary from country to country and the security can be difficult to enforce. For example, how do you secure iron ore in a smelting factory in the Ukraine?
In a typical transaction the lender will insist on security through a legal assignment of the commodity sale contracts – this enables the lender to step in and enforce the borrower’s right to receive payment under the contracts if required. The lender may also take an account charge over the particular bank account into which the sale proceeds are paid, enabling it to exercise control over this money until the loan and expenses have been repaid. Finally, a lender will aim, as far as possible, to take a pledge over the goods while in transit or in the borrower’s possession. This is where local law advice is essential given the varied requirements in different jurisdictions on perfecting security interests over goods.
Trade finance is a rapidly moving area of business with transactions taking place to tight deadlines often because of the perishable nature of the commodity being financed. Lawyers involved need to take the same approach with their work, as much focused on business practicalities as it is on providing sound legal advice to their clients.
Stephen Ridgway is a trainee solicitor in Denton Wilde Sapte's Trade and Export Finance group.